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Roth IRA vs Traditional IRA

There are a number of options for retirement investing outside your employer sponsored retirement plan, which is typically a 401(k). The two most common outside plans are a Roth IRA or a Traditional IRA. So what is the difference?

What is a Roth IRA?

The difference is rather simple; the Roth IRA allows you to contribute after tax dollars, meaning your money has already been taxed and there is no tax deduction on your contributions. So when you retire the money held within your Roth IRA is 100% tax free. This is the primary reason to invest in a Roth IRA, whether it is your only investment option because your work doesn’t offer a 401(k) plan, or if you are simply trying to increase your retirement savings. In 2016 the Roth IRA contribution limit is $5,500 ($6,500 if you’re 50+).

Roth IRA Rules

You may contribute at any age

Can’t contribute more income than you make

Income eligibility ranges based on filing status

Single: $117,000-$132,000

Married: $184,000-$194,000

$5,500 contribution limit ($6,500 if you’re 50+)

No tax deduction

No penalties on withdrawals of contributions

Interest earnings will receive a 10% federal penalty tax

No required minimum distribution (RMD)

What is a Traditional IRA?

The Traditional IRA is exactly like the Roth, only your contributions are tax deductible on both state and federal returns. The tax deduction gives you an immediate tax break the calendar year of your contribution. The Traditional IRA also has a contribution limit of $5,500 per year or $6,500 if you’re 50+.

Traditional IRA Rules

Must be under age 70.5 to contribute

Can’t contribute more income than you make

No income restrictions

$5,500 contribution limit ($6,500 if you’re 50+)

All or some may be tax deductible

If you are not covered by an employer retirement plan, you IRA contributions are fully deductible

If you are covered by an employer retirement plan, you may partially deduct your IRA contributions, depending on your income

You’ll pay ordinary income tax on withdrawals

10% federal penalty tax on both contributions and earnings

You must take your first required minimum distribution (RMD) by age 70.5

Why the Roth IRA is Best

The Roth IRA is absolutely your best option for a retirement plan, especially if you are a Millennial because you have ample time for your contributions to grow tax free. Even if you’re not a Millennial, a Roth IRA is your best bet.

Its hard to predict what your tax bracket will be when you retire 10, 20, 30, maybe even 40 years from now. Contributing your “taxed” dollars to a Roth IRA and letting them grow is a very sound retirement move. Just make contributions regularly via dollar-cost averaging and invest weekly or at least monthly.

I’ve never been a proponent of taking money out of your retirement accounts. Ever. But life does happen and if you don’t have an emergency fund, a Roth IRA can serve as one for you. I personally have an employer sponsored 401(k), as well as a Roth IRA. So I do look at my Roth IRA as a secondary emergency fund. I do have a fully funded emergency fund as well. All of your contributions to a Roth, not your interest earnings, are allowed to be withdrawn without penalty.

I’ve spoken with my Certified Public Accountant (CPA) and he agrees that a Roth IRA is a great retirement vehicle. My wife is a small business owner and I asked him if we should be contributing to a different retirement account for the tax benefits, and he told us not to do that until we max out our Roth IRA. That was first and foremost in his eyes. Then any extra after that can go to tax deferred retirement vehicles like the Traditional IRA, SEP-IRA, or Simple IRA.

13 Comments for “Roth IRA vs Traditional IRA”

Ive been meaning to read this and just never got a chance. Its an issue that Im pretty ineertsted in, I just started reading and Im glad I did. Youre a good blogger, one of the greatest that Ive seen. This weblog absolutely has some details on topic that I just wasnt aware of. Thanks for bringing this stuff to light.

I didn’t realize that you could continue to contribute to a traditional IRA until about the age of 70. It helps to know what time constraints we should plan for as we start investing in a financial plan like this. That way, we can feel a bit more empowered as we try to make decisions now that will benefit us and our savings going further into the future.

Thank you for your comment, Bernard. You can actually only contribute to an IRA (Roth or Traditional) if you have an earned income. So if you are still working in your 60’s and 70’s, then you can continue to contribute to a Roth IRA or Traditional IRA. Otherwise, once you begin to withdraw and take distributions from your IRA in retirement as your income, you may no longer contribute to said IRA. For example, if you are 69 years old and still working, you may contribute $6,500 to an IRA in 2017. If you are 72 and working part time, making $8,000 annually at a golf course, you may contribute $6,500 to an IRA in 2017. You can’t contribute more than you earn however. So if your part time gig only pays your $3,500 annually, then that is all you can contribute to your Roth IRA or Traditional IRA.